Microsoft Office, Server Sales Fuel Strong EarningsMicrosoft Office, Server Sales Fuel Strong Earnings

Microsoft Surface Pro: Is It Right For You?

Microsoft announced Thursday that its third-quarter profits were up 19% relative to the same period last year. The uptick beat analyst expectations and was propelled not only by lower-than-anticipated expenses but also strong server and Office sales. At face value, the numbers seem like a solid rebuttal from Microsoft to its critics; the company, already burdened with Windows 8's cool reception, has been a media punching bag over the last few weeks, with blows ranging from the PC's continued decline to Goldman Sachs downgrading Microsoft's stock.

The earnings report shows that Microsoft is a strong and diverse company, but it doesn't fully silence doubts. Windows 8 and the scope of Microsoft's influence are two of the open questions. What does Redmond's financial health mean for the future of personal computing?

As a whole, Microsoft's Windows division rose 23% to $5.7 billion, slightly below analyst projections. Given how much criticism Windows 8 has absorbed, that might seem like a vindicating number. This isn't the case.

Microsoft predictably declined to break down Windows revenue. It didn't explore how Windows 7 sold relative to Windows 8, for example. Surface sales were likewise unaddressed. Even so, there are many reasons to doubt that Windows 8 has performed well.

For one thing, the seemingly healthy numbers include deferred revenue from previous quarters. When this sum is removed, Windows earnings were essentially flat. There's also evidence that Windows 8 has struggled to gain market share, suggesting that even within the adjusted earnings, Microsoft's newest OS was not a strong performer.

[ Not sure about Microsoft's video calling software? Read 6 Skype Alternatives Worth Considering. ]

In an email, Gartner analyst Carolina Milanesi said she suspects "most of the revenue comes from software upgrades." Indeed, with PC sales down, it's unlikely that Windows revenue is coming from new machines. But Windows XP will lose support next year, and scores of businesses are still in the process of upgrading. Most of them have opted for Windows 7, resulting in the Windows division posting a strong quarter, even as its newest offering continues to flounder.

Though Windows 8 might not have been a standout performer in Q3, Gartner analyst David Cearley believes the OS can still turn things around. In an interview, he stated that whereas Windows 7 was a refined product, Windows 8 has "rough edges." He lauded Microsoft's bold moves, such as kernel-level unity across its various Windows platforms, but predicted Redmond will need one or two update cycles to add polish.

Indeed, with Windows Blue, a Win8 update expected later this year, Microsoft is accelerating its update schedule, demonstrating the urgent pace necessary to improve its products. The strategy makes sense but it remains to be seen whether Redmond implements the features users want, or if it simply offers uninspiring updates more regularly. Recently rumored tweaks include resurrecting the Start button, a move that would address one of Win8's most persistent UI complaints. It's a good start -- but how much more will Windows Blue need to effectively woo consumers?

Microsoft CFO Peter Klein, who announced alongside the earnings that he will step down as the end of this quarter, said Thursday that "small" touch-enabled Windows devices will arrive in coming months, a near-confirmation that 7-inch tablets, much-rumored in recent months, will soon join the Redmond stable.

Klein also revealed that the devices will have competitive price points, a key factor that could not only stimulate Windows 8 adoption but also cut into the iPad Mini's dominance of the mini-tablet market.

Still, many questions remain. What does "competitive" mean? And will these devices run Windows 8 or Windows RT? Intel's Bay Trail Atom processer will allegedly bring tablet form factors and battery life to devices that can run the full OS. If the cheapest models are RT-only, will consumers care? Windows Blue will have some say in this, and Microsoft could make up lost ground by targeting this budget-friendly market segment. Still, until the devices are in users' hands, it will remain difficult to handicap Redmond's chances. As a slew of 7-inch tablets might suggest, Microsoft knows that Windows 8 adoption will be driven more by tablets than traditional PCs. Klein frequently alluded to as much, mentioning that "consumers and businesses are increasingly shifting their focus to touch and mobility" and want "devices that are ultrathin, lightweight and have long battery life."

Gartner's David Cearley cautioned, however, that the tablet's rise doesn't mean that PCs are going extinct, or that Microsoft will stop making money from traditional computers. "Microsoft will continue to be an important anchor point," he said. He added, however, that Microsoft continues to struggle in the smartphone and pure tablet space, meaning that even if Redmond remains a dominant force in desktops and laptops, it could lose influence overall.

Though none of Microsoft's representatives acknowledged skepticism about Windows 8, Klein emphasized that the OS is a "complicated" transition and implied that its journey is far from complete. He optimistically referenced Windows Blue and its accelerated update pace as engines that will drive progress, but it's implicit in his forward-looking words that Microsoft knows it has ground to make up.

Redmond CEO Steve Ballmer was likewise focused on the future, pointing out that "bold bets" have positioned Microsoft for long-term growth. Redmond is clearly aware of shifting dynamics in the marketplace, and of uncertainty surrounding the future -- but what's less clear is where the company will stand once those shifts have played out.

In an interview conducted prior to the earnings announcement, Gartner analyst Stephen Kleynhans expressed confidence that "Microsoft understands the magnitude of the problems" Windows 8 faces. "They are a bunch of very smart people who have good ideas," he said but countered, "They also have this enormous install base they have to keep supporting which makes them slow to get new and interesting stuff into the market." He said the company needs to implement truly innovative ideas into its forthcoming products, even as it manages people who "don't want to leave their comfort zones."

In a blog post, Forrester analyst David Johnson said that though Microsoft is in "the throes of a market misfire with Windows 8," the company is diversified enough to "get through it." Indeed, Microsoft posted gains across all its divisions. The company's profitability is not at risk. But if Windows 8 fails to catch on, Microsoft's influence will be relegated to the enterprise, leaving it without a hold in the consumer market and the bring-your-own-device movement.

Cearley said the days of Microsoft controlling 90% of the computing market are over. Still, he said this shift shouldn't be viewed as a Redmond failure, but rather a natural progression toward heterogeneous environments. Enterprises will have to deal with Microsoft, Google and Apple, he explained, and IT departments are already adjusting to this sort of multi-platform support. Indeed, Cearley said that though Office remains a remarkably strong performer, it has lost ground to Google Apps. With consumers even more likely to own computing devices from many vendors, Microsoft's share of the overall computing pie can still be considerable -- but not as massive as before.

"It's not that Microsoft becomes irrelevant," Cearley said. "It's still very much a driving force, but it's not going to have the monopolistic and dominant position it once did."

To maximize its prospects, Microsoft will need to make progress with Windows 8. Dave Johnson noted the platform needs a stronger app library, and that Microsoft needs to better understand how consumer and workplace preferences differ. Offering a similar note, Forrester's J.P. Gownder, also writing in the aforementioned blog, pointed out that Windows 8's hybrid personality might be too compromised to succeed. He suggested Microsoft should offer one version of the OS for PCs and another for tablets. He said each could include both the desktop and Modern UIs but would be tailored to the specific device on which it runs -- e.g., booting to the Explorer interface on a PC while "keeping interoperability where it makes sense."

Whether Windows Blue adopts such thinking will become clear in coming months. Whatever the case, it's clear the update will play an important role in not only Windows 8's short-term growth but also Microsoft's long-term consumer mindshare.